Should Obama Bail Out 100 Cities?After Classic Bad Management!

The battle for bailout money is on. One side features the municipal bond holders. On the other are city pensioners, mostly senior citizens and even a few widows.
Of course, Detroit is ground zero for the battle. As we all know, the city’s liquidity crisis forced it into bankruptcy court. And everyone interested in government and big city finances is glued to reports from the court. Could the decisions made in Detroit set precedents for future cases?
It’s an important question, because more than 100 major cities are right behind Detroit. And anarchy could result if these cities don’t get more cash.

Many of the problems are immediate: How do we keep the garbage trucks running, or the libraries and schools open?
Other problems are more long term, such as lowering the payroll costs in a heavily unionized sector, like local government, without inciting debilitating strikes.
Finally, some problems are both long-term and nearly intractable. For instance, how can we restructure an entity that has gorged on cheap debt for decades without scaring off investors? Those investors will be necessary for rolling over debts coming due.
If we look at some of the numbers, we see the problem in a microcosm. Here’s an example: The Detroit sewer and water systems are a cash machine. In fiscal year 2012, they generated $403.6 million. Based on that cash flow, Detroit borrowed and spent $5 billion against the assets in the municipal bond market. Today, the interest payments are $356 million annually, and that’s before even a penny of bond principal is paid back to the lenders.
Customers want their toilets to flush, workers want to get paid, retirees want to get paid, and the lenders (or, in this case, the bondholders) want their money back. But not all of these groups are going to be happy with what happens during the bankruptcy proceedings.
A Spreading Malaise
And don’t think Detroit is isolated. Just this month, Chicago had its debt downgraded, so Mayor Rahm Emanuel responded by laying off more than 2,100 Chicago Public School employees. Nearly 1,000 of the layoff notices went to teachers.
Fundamentally, cities, school districts and other governmental agencies across America were given the luxury of overly cheap debt. Instead of making hard decisions about priorities, they turned to the municipal bond market to borrow money to cover operating expenses, pension obligations and the cost of servicing billions of dollars in past debt. Since 2005, the muni bond market in the United States has exploded from $1.9 trillion to $3.7 trillion.
Municipal bonds have become the latest speculative bubble afforded by the QE policy of the Federal Reserve and Ben Bernanke. Wall Street went wild with the easy money, and the bonds are being traded and re-traded on the market. The “too big to fail” financial institutions – controlling vast sums of mostly borrowed capital – as well as the hedge fund managers, insurers and brokers who control these muni-bond markets, have made billions.
But now it’s become apparent that there’s distress in the market – evidenced by spiking borrowing costs. Other governments besides Detroit are having difficulty borrowing because they’ve gotten used to the low rates that funded the boom.
All I can say is, get ready for the bust… it’s just around the corner. In fact, it’s already starting.
Genesee County, Michigan, just pulled back from issuing $53 million in bonds after investors demanded higher interest rates.
Battle Creek, Michigan, announced it would pull a $16-million issue until market rates returned to the ultra-low rates from before the Detroit bankruptcy filing.
And we should expect more busted muni bond deals going forward. I recommend staying away from the market.
Obama on Deck
The pressure is building on Obama. Recently, union leaders demanded an “immediate infusion of federal assistance for Detroit… Bankruptcy must not be used as a tool to impoverish city of Detroit workers or retirees. City workers have already made severe concessions to keep the city afloat… They are not to blame for Detroit’s financial problems, yet they have been making sacrifices all along the way to help the city out.”
As pressure builds and Chicago’s finances continue to deteriorate, expect Obama and team to fashion some type of bailout for the muni bond market and the big cities like Detroit, Chicago, Los Angeles, etc. that are in desperate need of cash. It’s really only a matter of time.